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Tuesday, August 5, 2014

Irregular expenses are a big topic in budgeting, so to ensure it was explained clearly, I turned to my husband Bryan (a non-accountant) to explain how we budget for our non-monthly expenses (e.g. car repairs, insurance, property tax, etc.). Bryan's just a regular guy who been sucked into my budgeting madness. Here he is holding our two boys (I know--they're all pretty cute).

Note that the example below is for known expenses, but we also use it for some of our "unknown" expenses (e.g. car repairs and general savings) using estimated amounts. So when we have big car repairs, they're already saved for. We simply pull the money out of this account that has been accruing savings for months and months. It'd worked like a charm so far.So without further ado, here he is:

We have all been there, you are going along, life is good, the checking account is growing and then all of a sudden, those big expenses hit and you are scrambling to pay for everything. Budgeting to the rescue! A few weeks ago Lisa asked me to write about how we set our budget to accrue monthly for expenses that occur once or twice a year. This system helps to level out the known planned expenses by saving for them every month.

To start off, I am sure there is some accounting principle that Lisa could explain around this, but the easiest way for me to explain it is that we know some expenses happen a few times through the year (life insurance, property tax, car insurance, etc.) and we take the annual amount (say $1200 for car insurance) and then divide by 12 to get our monthly amount of $100. At the beginning of each month, I transfer the sum of all those monthly amounts into our savings account (a separate checking account at an online bank). See the example table below.

Expense

Annual amount

Monthly Amount

Car Insurance

$1200

$100

Homeowners Insurance

$600

$50

Life Insurance

$500

$42

Property Tax

$4000

$334

In the example above, the monthly transfer is $526.

When the bill comes to pay those expenses, we pay them out of our savings account (where the money have been accruing and collecting interest). The true beauty of this system is that there is no worrying about how we are going to pay the property tax bill, or the car insurance bill, because we have already paid it. The table below outlines an example of how the system would work

Jan

Feb

Mar

Apr

May

June

July

Aug

Sept

Oct

Nov

Dec

Start

2000

2526

1052

1078

1604

1830

1756

2282

808

1334

1860

2086

Additions

526

526

526

526

526

526

526

526

526

526

526

526

Expenses

0

2000

500

0

300

600

0

2000

0

0

300

600

Ending

2526

1052

1078

1604

1830

1756

2282

808

1334

1860

2086

2012

Our budget is happy because we avoid the stress of seeing the monthly budget in the red. And we are happy because all the stress associated with trying to pay the big expenses disappears as we have already paid for them. The key to making this system work is to move the money into a separate account. The reason why this is important is so that you are not tempted to spend it, or think you have enough savings.

This system takes some discipline and I would strongly encourage you to set auto transfers to make it easier. But the pay off when the expenses hit is completely worth it.

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